What’s the difference between building income and building wealth?

I have built a reputation for helping people who are struggling financially get a better handle of their finances. If you’re a regular reader of my column, you’ve probably noticed that I devote a great deal of time writing on topics such as budgeting and getting out of debt. Based on this fact, you may have formed the conclusion that only people who are buried in debt or people who are in dire need of a budget can use my services. Contrary to popular belief, I also help people who are doing well financially, do better. My true mission is to show people how to beat debt, save for emergencies, become properly insured, pay cash for big ticket items, build a respectable retirement nest egg, fund their children’s college fund, payoff their mortgage early and build wealth.

It is my fundamental belief that you don’t have to have a fortune to start building one. However, in order to amass a fortune you do have to START building. The reason why I spend so much time writing about budgeting and getting out of debt is because budgeting and getting out of debt are the foundational pillars required in order to build wealth. You see, a budget is a spending, saving and investment plan. The word budget and financial planning are interchangeable words. Debt is hazardous to your wealth! Debt ties up your most powerfully wealth-building tool—which is your income. The reason you can’t save for emergencies or save up cash for big-ticket item purchases is because your income is tied up in payments—debt. The reason you can’t fund your children’s college fund or invest in and/or preserve a retirement portfolio without making early withdrawals or loans against it is because your income is tied up in payments—debt. Until you have a budget, your consumer debt under control, and a fully funded emergency fund, you’re not ready for investing—let alone building wealth.

The client who posed this question, “what’s the difference between building income and building wealth” has been there and done that. She has no consumer debt, a fully funded emergency fund, and she has a financial game plan that I helped her fine tune. She was well on her way to millionaire status and would have made it whether she followed my advice or not. I just helped her to expand her goals and fully understand personal finances and the investment world.

What’s the difference between building an income and building wealth?

Building an income requires one thing. You get up and go to work. Of course we all want to earn as much income as humanly possible. To max out your earning potential, you simply have to become so good at what you do that people will do any and every thing to acquire your services or products. Can you say Johnny Cochran? Comedian Earthquake said that in the height of Michael Jackson’s child molestation trial, Michael attended Johnny Cochran’s funeral and tried to pull Johnny out of the casket crying and caring on saying don’t leave yet Johnny—I need you (joke). I recently had a client make an hour drive so that I could prepare a financial plan for him. I’m sure this client drove past many other financial advisors on his way to meet with me. But it was something he heard about me that made him drive a full hour to meet with me. After the appointment, I thought to myself I’m on my way.

When one thinks about building wealth, the general idea is having FREEDOM. The irony is so many people want to build wealth and be financially free but they miss the point that as long as you have debt, you have shackles claiming both your income and your financial freedom. As a result in order to build wealth, it’s imperative that you get out of debt. Mike Tyson was so good at the game of boxing that he generated untold sums of money in that sport. Yet he went bankrupt. His income was large but he was not FREE. The scriptures say it this way—“The borrower is slave to the lender.” Are you still wondering why I talk so much about getting out of debt?

The second component to building wealth is the slowly but surely shift your income sources from active income also known as earned income to portfolio and passive income. Active income is a result of your physical efforts. You have to get up, roll up your sleeves and get your hands dirty to create an earned income. Portfolio income on the other hand is income from interest, dividends, capital gains and royalties. This is your money working for you instead of you working for your money. If you can build a nest egg worth $1 million dollars with a 12 percent average rate of return, you can live off 8 percent, let the other 4 percent cope with inflation and have an annual income of $80,000 without touching the principal—the goose that laid the golden egg. Passive income is income from sources that does not require you to materially participate such as rental income. Materially participating requires that you actively engaged in the operation of the business on a regular, continuous, substantial basis. If you want to buy and hold real estate, the ideal situation is to own free-n-clear rental properties so that mortgage payments aren’t cutting into your rental income.

Once you’re able to live off the income generated by your assets instead of your time and efforts, you have in effect become wealthy. It was rumored that Bill Gates does not even take a paycheck anymore.

(Damon Carr is owner of ACE Financial. He can be reached at 412-856-1183 or visit his website at http://www.allcreditexperts.com. ACE is the Place for Mortgages and Financial Planning.)